Paul Tepsich is managing partner and portfolio manager at High Rock Capital Management. His focus is Canadian small-mid caps and fixed-income.
Athabasca Oil (ATH.TO)
This senior producer secured second-lien bond moves from a call price of $103.75 to 100.00 on 11/19/16. ATH will have about $900-million of pro forma cash after a joint venture with Murphy Oil and only about $800-million of debt, making it likely the only oil and gas exploration and production company on the continent in a net cash position. About $250-million of that debt is effectively bank debt (Term Loan B) that doesn't mature until after the bonds in May 7, 2019, but interestingly, the TLB has what is called a "springing maturity" built into it. What this means is that if the bond is still outstanding six months before it is due (May 19, 2017) then the TLB becomes due immediately. Effectively, ATH will need to either refinance this $550-million bond, call it and retire it with their substantial cash position, or a combination of both. The company has said they will pay down about $350-$400-million of debt this year. We feel very confident that this bond will be called on Nov 19, 2016 at $100.00. With a purchase price of $92.25, we see a total return of about 13 per cent, with little execution risk.
Superior Plus made a formal bid for 100 per cent of chemical maker Canexus back in October, 2015. The ratio is .153 SPB shares for every CUS share owned. This transaction is waiting on regulatory approval from U.S. and Canadian competition regulators, which we expect to come through any day. Currently, CUS is trading at about a 15-per-cent discount to the deal value. We see little risk in this deal not going through, as the sodium chlorate business of CUS that SPB covets is largely a B2B product and consumers are not likely to be negatively impacted at all. So we see about a 15-per-cent lift in our CUS position once the deal goes through, followed by further upside in holding the new SPB shares for two reasons:
1) We feel SPB is under-promising and will over-deliver on the cost savings inherent in CUS once acquired and merged;
2) We think SPB is a well-run company that will eventually split up or sell off their three distinct divisions.
30-Year Government of Canada Bond
This is the on-the-run 30-year Government of Canada bond. We recommend owning some, not so much for capital gains, but rather as a protective measure as part of your portfolio. Although these bonds only yield about 2.10 per cent, they provide some portfolio insurance in case there is a big sell-off in risk assets like stocks, as there will likely be a flight to safer assets in the event of a sell-off.
The other big reason to look at owning them is that if there is an unexpected deflation shock, long bonds will rise substantially. If inflation is the enemy of long bonds, then deflation is the friend of long bonds. Too few people own a healthy weight in long-dated government bonds as part of their portfolio diversification and risk management.
Being long government long bonds is arguably the most simple form of portfolio risk management that we know of. Unlike options where you need to pay an ongoing premium, not to mention their complexities, government long bonds actually pay you to be long! It may not seem like much, but at least you are getting paid and there may be upside potential for capital gains too.
We are quite cautious on risk assets right now, especially stocks. Stock markets are almost at all-time highs, yet U.S. corporate earnings are declining at rates not seen since 2009. The most recent rally has been led by yet more central bank easing, or at least dovish comments. What we have seen over the past few years is a move toward global competitive currency devaluation. Most central banks saw the opportunity to devalue their currency, export their deflation to the shores of the U.S., as it was arguably one of the only economies showing any sort of growth.
Well, in the first quarter of 2016, the Fed decided the U.S. dollar was just too strong, and it moved to a slightly more dovish stance, thereby weakening the U.S. dollar as well. The question for the markets should be, "Is the U.S. economy strong enough to import all of the world's deflation and turn it into inflation?" We are not so sure it is and think there is an unexpected risk of deflation, which scares central bankers.